Spanish risks spur demand for safe assets

Richard Hubbard

5 IN. DI LETTURA

LONDON (Reuters) - The hunt for safe-haven assets in Europe spread to Austrian and French bonds on Thursday, although European shares and the euro regained some stability, as worries over Spain and its troubled banks weighed on market sentiment.

A graph is seen above a worker as he puts the finishing touches to a stage decoration for an investment funds awards dinner at the Madrid stock exchange May 17, 2012. REUTERS/Paul Hanna

The single currency and world shares are poised for their biggest monthly drops since last September, while the fall in oil prices in May is set to be the largest for two years, as the escalation in the euro-zone crisis has stoked investor worries over the impact it could have on the global economic outlook.

“There’s a huge amount of flight-to-quality moves right now. Only a policy coordination in Europe can stop this,” said Ayako Sera, senior market economist at Sumitomo Mitsui Trust Bank.

Concerns about Europe’s debt crisis and the lack of any coordinated policy response have risen since Spain unveiled unconvincing plans to recapitalize nationalized lender Bankia (BKIA.MC), raising the possibility it could need outside help.

These worries kept Spain’s 10-year bond yield at 6.66 percent, near Wednesday’s euro era high of 6.79 percent and close to the crucial 7 percent mark, which has led to other troubled nations like Portugal and Ireland needing bailouts.

Yields on French and Austrian debt fell on Thursday to their lowest levels since the euro was launched 13 years ago, as investors, fearing the outcome in Spain, sought refuge in non-German debt that offered relative safety.

The safe-haven demand has already pushed German government bonds to record low levels, with the two-year German Bund offering investors just 0.02 percent in yield.

Germany’s 10-year bond yield was just 1.28 percent, although bond are offering slightly better levels than Wednesday’s record lows.

French, Austrian and Belgian yields were all some 10 basis points lower on the day at 2.39 percent, 2.16 percent and 3.11 percent respectively.

“It feels that we’ve now moved into the ‘Intervention Zone’ where all paths lead to the next major round of action from the authorities,” said Deutsche Bank’s fixed income strategist Jim Reid, in his morning note to clients.

“It’s difficult to see how the market regains its poise without it.”

NEXT MEETING

The problem investors face is that the next meeting of European leaders is not until the end of June, before which Greek voters could on June 17 return a new government opposed to the current bailout plan - forcing an unprecedented exit from the euro zone.

The euro fell as low as $1.2358, a level last seen in mid-2010, before recovering to trade up 0.3 percent at $1.2410.

Traders said expectations that Ireland would vote for Europe’s new fiscal compact, in a referendum on Thursday, helped the euro recover, but any gains were expected to be short-lived.

“We could see a very brief pause in the downtrend in the euro because of the Irish referendum, but beyond that the news is fairly negative,” said Ian Stannard, head of European currency strategy at Morgan Stanley.

“There is very little on the horizon to provide sustained support and the trend is clearly downwards.”

The single currency is on track to lose about 6.6 percent in value against the dollar this month.

Meanwhile the major beneficiary of safe-haven demand, the greenback, stood at 82.79 .DXY as measured against a basket of major currencies, after hitting a 20-month high of 83.11.

European shares opened slightly higher after steep losses on Wednesday, with the FTSEurofirst 300 .FTEU3 up 0.2 percent at 977.74 points, but still on track for its biggest monthly loss since August when markets were similarly beset by fears over Europe’s debt crisis.

Equity markets are shifting their focus to data from the United States due out later, including May’s ADP National Employment survey and the latest weekly initial jobless claims number, which will provide pointers towards Friday’s all-important U.S. May nonfarm payrolls report.

Brent crude reversed early losses and climbed towards $104 per barrel, but a bleak demand outlook linked to the impact of the euro zone debt crisis kept gains in check.